For Cepheid, the Diagnosis Is Disappointing

THE BIDDING WAR OVER BIOSITE, a medical-diagnostics company, has sent other potential buyers looking for opportunity in the diagnostics sector.
Biosite
(ticker: BSTE) agreed to a $1.6 billion bid from
Beckman Coulter
(BEC) last month, and then got a $1.75 billion bid from
Inverness Medical
(IMA), which Biosite says it will consider.

Mad-moneyed television commentators then pointed to
Cepheid
(CPHD) as the next diagnostics takeout. This publication mentioned Cepheid recently, as a possible beneficiary of an innovative program for fighting infections at hospitals run by the Veterans Health Administration ("Turning Khaki Into Green," March 26).

These attentions sent shares of Cepheid scooting from 7.40 last month to a recent high above 12, which is where it ended Friday. At current levels, the Sunnyvale, Calif.-based company is valued at about $650 million, which is equivalent to about 5.5 times Cepheid's guidance for 2007 sales -- the same multiple of sales being paid in the Biosite takeover. For Cepheid to have upside, therefore, it would need to be a better business than Biosite.

Talk to Cepheid's chief executive, John L. Bishop, and you might entertain such a notion. He compares Cepheid's diagnostics system to Microsoft Windows, saying it makes a previously arcane and expensive technology available to the masses.

Comparisons of Cepheid to
Microsoft
(MSFT) -- and Biosite -- are strained, for many reasons.

One simple difference is that Biosite earns robust profits on its sales of antibody-based tests for disease and drug abuse. Cepheid repeatedly has claimed to have found a profitable application for its tests, which use a chain reaction to amplify telltale molecules of a virus or bacterium. But Cepheid's achievements have fallen short of its forecasts.

The company predicted it would make a profit in 2006, for example, after supplying bioterrorism-screening systems to the U.S. Postal Service; the systems check for anthrax spores. Instead, Cepheid's losses nearly doubled to $26 million, or 50 cents a share, as 2006 revenues grew all of 3%, to $87 million.

Bioterrorism-related revenue was a big 58% of Cepheid's sales total, but actually fell 17% from the prior year. Cepheid chief Bishop says he expects bioterrorism sales to stay flat this year, but the company has had trouble signing a new contract with the Post Office since the last one expired.

Solid Advance: The Nasdaq rose 0.8% last week, to 2491, its third weekly gain in four weeks. The index is at its highest level since Feb. 26, even though many tech stocks ebbed.

Now Bishop eagerly directs investors' attention to the next big opportunity for Cepheid: infection-control testing at hospitals like those run by the Department of Veterans Affairs. The VHA system has started a program to reduce the spread of antibiotic-resistant staphylococcus bacteria in its approximately 142 hospitals. Cepheid is in the process of getting its test for drug-resistant staph germs cleared by the Food and Drug Administration.

The hospital would swab inside the nose of a new patient, and then drop the swab into Cepheid's GeneXpert cartridge. Just 70 minutes later, it would know whether to quarantine the patient. Tests like Cepheid's are marvelously accurate.

Chief Executive Bishop portrays a huge opportunity for such drug-resistant staph tests. If adopted by intensive-care units of all U.S. hospitals, the market would be 10.5 million tests a year, or $357 million at Cepheid's test price of $35 apiece.

If every hospital and emergency-room patient got tested, Cepheid glowingly predicts a $1.25 billion annual market. Cepheid also points to tests for cancer and infectious viruses that could expand its markets beyond $7 billion in total.

AGAIN, CEPHEID SEEMS to be getting ahead of itself. The opportunity at hand is the veterans program. While some VHA hospitals have requested bids for systems like Cepheid's, the program anticipates other approaches to infection control, such as stricter gowning and gloving.

Even in the clinical-testing department, Cepheid has competition.
Becton Dickinson
(BDX), for instance, has a molecular diagnostic test that's 10 bucks cheaper than Cepheid's anticipated price (although not, Cepheid claims, as easy to use). Becton Dickinson also has a 24-hour test that sells for just a few dollars. Cepheid's Bishop acknowledges that his rivals will get a fair share of any orders from the VHA.

One of the few analysts to attempt a reasoned estimate of the veterans opportunity for Cepheid is Daniel Owczarski of Chicago's Belmont Harbor Research (who disseminates his reports through Soleil Securities). Owczarski figures that Cepheid could get its systems into the intensive-care units of about 40 VHA-run institutions. At 75% occupancy of a 15-bed ICU, and a six-day average length of stay, he foresees the VHA using 27,500 tests a year.

Assuming a generous $40 per test for Cepheid, the analyst concludes that the VHA program would add just over $1 million in test sales to the company's annual revenue. That wouldn't do a lot to reduce Cepheid's annual losses. So even if Owczarski is low by several-fold, the veterans business is likely to prove another disappointment to Cepheid's hopes of wringing profits from its molecular-testing technology.

Bishop believes that infectious-disease testing will bring Cepheid operating profits by the fourth quarter of this year, at least if you don't count stock-option expenses and other non-cash charges.

Needless to say, he thinks that an analysis like Owczarski's is too pessimistic. "I would put that on the conservative side of what's in fact happening out there," says Bishop.

Investors who are inclined to take a liberal view of Cepheid's prospects, however, are already paying through the nose.

I've been a "Crackberry" user for more years than I care to remember, and I love the darn thing. So seeing that the latest model copies the Pearl and does away with the familiar scroll wheel on the side in favor of an IBM-like trackball pointer on the front was a nasty shock -- and I was quite prepared to hate the unit.

But I don't -- hate it, that is! Oh, sure, I wish it had a scroll wheel instead of the volume up and down buttons that replace it (who uses them?), but to my great surprise, the pointer isn't unpleasant. It works and works quite well, a new button also on the front serving as the "back" button.

The 8800 is slightly longer and slimmer than its predecessors and really great-looking, with raised Qwerty keys that remain easy to hit. The screen is downright fabulous, easily up to viewing stored photos, downloaded videos and even movies. Along with the usual address book, calendar and browser comes a program called TeleNav, which uses the built-in GPS capability to display your location and find addresses on downloaded maps -- great if you're visiting an unfamiliar city.

With sales of smart phones like the 8800 expected to rise 50% annually over the next few years, BlackBerry maker
Research in Motion
(ticker: RIMM) is sitting pretty.

So were RIMM investors, until last week. The stock, which had more than doubled in 12 months, slid over 8% Thursday on a revenue report that disappointed Wall Street.

-- Jay Palmer

For Cepheid, the Diagnosis Is Disappointing

THE BIDDING WAR OVER BIOSITE, a medical-diagnostics company, has sent other potential buyers looking for opportunity in the diagnostics sector.

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